Philadelphia should address its basic issues

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Philadelphia held its bond investor conference last week. Although the press was not allowed to attend, the city did post the presentations on its website. Philadelphia Inquirer reporter Joe DiStefano neatly summarized the city’s political and fiscal position, which is not as rosy as the presentations make it seem:

Philadelphia hopes to borrow more than $1 billion by selling or refinancing bonds over the next nine months. For all the city’s growth around Center City, the colleges and the Navy Yard, officials face some big challenges: the lowest credit ratings of the biggest U.S. cities (low credit ratings tend to boost borrowing costs, though current interest rates are near rock-bottom levels); the financial near-collapse at the School District; the scheduled end of the sales-tax surcharge; labor negotiations and court decisions that have mostly upheld city labor union positions and reversed Nutter administration cost-cutting schemes; a thwarted real estate tax reform; stagnant office growth; high poverty in worn city neighborhoods; and more.

Philadelphia’s most important fiscal problem is its relationship with the city’s unionized employees. The city summed up the problem in the investor presentation (page 19). Note that the city has had no new agreements with three of four municipal unions since 2009, and that most employees have the right to strike.

The city’s pension fund has about 48 percent of the assets needed to cover its liabilities. To fix the pension shortfall, taxes must be raised, employees must contribute more, or both. To make a significant dent in the $5 billion unfunded pension liability, the city would need to contribute at least $200 million per year to the fund. The city has previously deferred pension contributions, and it is forced to make it up in 2013 and 2014, as seen in the gray bars below. Instead of raising its pension contribution amount after 2014, it looks like the city intends to return to the pension funding levels it had in 2012 (page 1, line 10). Essentially, it looks like the city intends to let the pension fund run down further. No one can stop it from doing this unless the state steps in.

Instead, it appears that the city intends to issue around $800 million in new money bonds this year. It will use the money that paid for pension deferral obligations to service $400 million in new general obligation bonds and $200 million in Philadelphia Authority for Industrial Development (PAID) bonds. The city will also seek to issue $200 million in Water and Wastewater Revenue Bonds to be repaid with Water Department revenues.

Mayor Michael Nutter has been pushing hard to sell the crown jewel of the city, the Philadelphia Gas Works. The Gas Works makes money and remits $18 million a year to the city. It funds its own capital improvements with internal cash flow and its pension plan is 70 percent funded with a $150 million shortfall. It’s not clear why the city would sell the Gas Works, except to get a quick shot of cash. The Inquirer’s Joe Destefano referenced a report by Ryan Connors, the utility analyst at Janney Montgomery Scott, who warned in a report last week that a PGW sale will be politically difficult.

After Philadelphia pulled the kimono back it was clear why the city wanted to exclude media from hearing the presentations and asking follow-up questions. There is simply not enough money to do all the things the city is trying to do, especially with an unstable labor situation. Philadelphia would be wise to slow down borrowing and put more attention into fixing structural issues. There is also this silly error in the investor presentation (page 14):

$4.1 million to hire 400 policemen would be about $10,000 per safety officer, which usually cost about $100,000 each. The figure should probably be $41 million. On top of everything else, we get this:

Dept. of Great Timing: Mayor Nutter announces bid to host Olympics as Council grills Admin on reduced public safety $$ #muniland

Author Profile

I’m Cate Long and I write about the retail fixed income markets including municipal bonds. My primary interest is creating tools and systems to help retail investors understand bond markets. I’ve worked for a number of years with industry standards organizations, regulators and Congress to help craft a more transparent and fair framework for investors to participate in the fixed income markets. I'm a guest contributor to Reuters.com. Any opinions expressed are mine alone.